The Breakout must be Tested to be Real

By all reckoning, the US dollar had a good week. It rose against nearly all the major currencies, and against many broke out of recent ranges. Ironically, the dollar gains more mostly scored before the surprisingly strong Q1 GDP print of 3.2%. In fact, all the major currencies but the Norwegian krone recouped some of their recent losses ahead of the weekend. Nokkie appeared to have been weighed down by the biggest drop in oil prices in a couple of months after setting six-month highs earlier in the week after the US announced it was not going to renew any waivers that exempted a handful of countries from the embargo against Iran.

Some purists argue that just like space has a shape so does nature. Technical analysis is about uncovering these shapes in prices. Fibonacci relationships exist in nature, for example, they can be found in the markets too. Another school argues that technical analysis is a study of group psychology. Individuals may learn, but groups apparently do not, and behavior (patterns) are often repeated. Two elements of market psychology have percolated into pop culture.

First. Peter Coy, a journalist at Bloomberg's BusinessWeek has an incredible skill to tap into this psychology repeatedly over the years, writes the recent cover story, highlighting the argument that the scourage of inflation has been overcome: "Researchers are finding that low inflation is in large part a consequence of globalization or automation or deunionization—or a combination of all three—which undermine workers’ power to bargain for higher wages. In other words, the capitalists killed inflation."

The other element that many are citing as structural is the decline in volatility in the capital markets. Some observers link the low volatility to the increased importance of China and its managed markets. Previously, many attributed it to the asset purchases of the central banks. The idea is low volatility is part of a new normal, just like low inflation.

It often seems to be a signal that an inflection point has been reached when psychology attributes what had been cyclical, episodic, or periodic to structural changes, like why house prices can only go up or why peak oil meant ever higher oil prices. To be clear, this is not a forecast of an imminent rise in inflation, though the rally in oil to six-month highs and the dollar's rise will likely lift headline measures in the coming months. Nor it is a warning that volatility is going to spike, though the six-month moving average of the VIX reached a three-year high in March, before pulling back this month. The implication is that there is much dry tinder for a fire. Where the spark comes from seems serendipitous. It is another sign of extreme.

Dollar Index: Barring the unlikely dramatic sell-off in the coming days, the Dollar Index is poised to close higher for the third consecutive month. It has risen for nine of the past 12 weeks and last week rose to its best level since May 2017. Around 98.00, it is still a ways off of its cyclical high from January 2017, just above 103.80. Chartists may note that the 50-week moving average will likely cross above the 200-week moving average in the coming days. This "golden cross" is seen as a bullish sign, but when the 50-week average went below the 200-week in March 2018, the sell signal was at the bottom. The "golden cross" on the daily charts generated its buy signal in June 2018. The technical indicators are constructive but extended. The Dollar Index closed above the upper Bollinger Band on Wednesday and Thursday last week before closing below it ahead of the weekend. The upper Bollinger Band comes in near 98.10 at the start of the new week. Previous resistance in the 97.35 area should serve as initial support.

Euro: As soon as the Easter holiday was over, the single currency was sold, and it reached the lowest level since May 2017 just ahead of $1.1100. After making a marginal new low in response to the US GDP surprise, the euro recovered and traded above the previous day's high. The reversal was marred by the fact it failed to close above that high (~$1.1160). If the euro's downside break is "real" it ought to encounter selling pressure around $1.12, and the failure to break above $1.12 could turn the sights on $1.10. The MACDs and Slow Stochastics give little reason to think that a low is in place. The lower Bollinger Band begins the week near $1.1140. The downside break poked volatility higher. The implied three-month jumped from 5% through 6% before settling near 5.6%. The three-month risk reversals (put-call skew) that had been flirting with parity, quickly moved favor puts by the most in a couple of months. Volatility rose, so the new flow was to buy options, and the put premium over calls rose, so the new flow was likely buying euro puts.

Yen: The yen fell to new lows for the year in the middle of last week, but then a short-squeeze ensued, and the yen rallied. It seemed that many participants wanted to close out short exposure ahead of the extended holiday (two weeks) remembering too well the flash crash (yen rally) in early January in holiday-thin markets. What this means is that the US dollar posted a key reversal on the weekly bar charts by trading on both sides of the previous week's range and finishing below its low. Other technical developments also warn of near-term dollar losses. In the last two sessions, the dollar closed below the uptrend drawn from the flash crash lows and the March lows. The mid-April lows approached the trendline, which begins near JPY111.85 and finishes next week around JPY112.10. The Slow Stochastics have turned lower, and the MACDs have crossed. The five-day average is set to fall below the 20-day average. Initial support may be found in the JPY111.00-JPY111.25 range, but a break of the recent low near JPY110.80 would be more significant.

Sterling: April has been cruel to the UK. It is still in the EU and has no clearer idea of how it is going to leave by the end of October, the new, and now said to be the final deadline. Sterling began the month near $1.31 fell to almost $1.2865 last week, before bouncing to around $1.2950 ahead of the weekend. $1.28 area is a 61.8% Fibonacci retracement of the rally since the flash crash. The RSI has turned up, and the MACDs and Slow Stochastics look as if they are about to do so. The 100- and 200-day moving averages converge around $1.2960-$1.2965, and important resistance is seen in the $1.2970-$1.3000 range. A failure to surmount would likely signal a running start at $1.28.

Canadian Dollar: A softer shade of neutrality by the Bank of Canada lifted the already-bid greenback to CAD1.3520, its best level since January 3. The US dollar consolidated its gains by moving lower in the last two sessions. The RSI has turned down, but the MACDs and Slow Stochastics may be near turning, but they haven't yet. The upper Bollinger Band is about CAD1.3480. The CAD1.3400 level marked the previous trading range. It should now offer the US dollar support. The other drivers we look at like the 2-year interest rate different peaked near 80 bp in the middle of the week but fell back to near 73 bp, to post its narrowest close since April 1. The S&P posted a new record closing high before the weekend. Oil prices fell for the last three sessions.

Australian Dollar: Stronger than expected jobs data saw the Aussie peak this month on April 17 just above $0.7200, the upper end of its two-month range. By the time the softer than expected inflation data were reported, it was a cent lower. It briefly dipped below $0.6990 for the first time since the flash crash but recovered to close above $0.7000. The gains were extended ahead of the weekend, with a test on $0.7060. The technical indicators are mixed. The RSI is consistent with a bottom being in place more than the MACDs and Slow Stochastics, which are still trending down. A push above $0.7100 would likely stabilize the technical tone.

Mexican Peso: The dollar climbed to almost MXN19.20 on April 25 before reversing lower and retreating further ahead of the weekend. It closed a little below MXN18. 94. We had identified the MXN19.20 level, where the 61.8% retracement of this month's dollar decline was found, as the technical target. Even with the drop of nearly 0.8% decline last week, the peso is this month's strongest currency with a roughly 2.6% gain. Year-to-date, it is up 3.75%, making it the second strongest, behind the Russian rouble's 7.35% gain. The high rates available in Mexico coupled with the currency appreciation makes this one of the favorite plays in the leveraged community.

Oil: Light sweet crude oil prices tumbled 4.5% in the past three sessions, stopping a seven-week rally cold. The sell-off erased all the gains scored on the announcement of about the waivers, and WTI for June delivery closed 1.2% lower on the week. There may be "buy the rumor, sell the fact" kind of activity. Trump has already renewed his calls for help from OPEC. June crude closed the week below its 20-day moving average ($63.75) for the first time since February 11. The RSI and Slow Stochastics show a bearish divergence in that they did not confirm the move to new highs. The measuring objective of the head and shoulders pattern that was carved out in November through January was in the $66-$67 area. The objective was met with a high of $66.60. The reversal was not complete as the June contract failed to close below the previous week's low despite trading below it.

US Rates: The US 10-year yield fell six basis points last week, the most in five weeks and closed below 2.50% for the first time in two weeks. Half was recorded after the GDP figures. The two-year yield shed 10 bp to 2.28%. Half of it too was registered after the GDP report. It is the lowest close of the month. Turning to the June 10-year note futures contract, the pullback this month brought the contract in a three-leg (A-B-C?) down move to the 61.8% retracement of the rally from early March. It came in near 122-26, and the intrasession low was 122-20, but it never closed below the retracement objective. The recent gains and push higher ahead of the weekend saw the June contract recoup half of what it had lost. A move above 124-00 would boost the chances of a retest on the late March high near 125-00. The January 2020 fed funds futures contract implies an average effective funds rate of 2.18% now compared with the present average of 2.44%, indicating a 25 bp rate continues to be discounted. By emphasizing its neutrality, the Fed pushes back.

S&P 500: After a dip on Wednesday and Thursday, the S&P 500 closed at new highs for the week, which was a new record closing high. The intrasession record that was set at almost 2942 last September remains intact. The S&P 500 has suffered a weekly loss only four times in the first 17 weeks of the year. The technical indicators look stretched, and the Slow Stochastics may be setting up a potential bearish divergence. Assuming that the window dressing at month end is modest, the S&P 500 will close higher for the fourth month in a row. It is taking a month-to-date gain of 3.75%, the most since January into the last couple sessions of the April.

Disclaimer

The Breakout must be Tested to be Real
Reviewed by Marc Chandler
on
April 28, 2019
Rating: 5